Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Price ceiling = legal maximum price. Binding only below equilibrium → shortage; quantity traded = Qs.
- Price floor = legal minimum price. Binding only above equilibrium → surplus; quantity traded = Qd.
- Quota = legal maximum quantity. Buyers pay the demand price at the quota; the gap above the supply price goes to licence holders.
- Per-unit tax on sellers: supply shifts up by t. Per-unit subsidy to sellers: supply shifts down by s.
- In an efficient competitive market, all of these lower total surplus. The lost surplus is deadweight loss (DWL).
Key relationships
| Quantity | Formula |
|---|---|
| Tax revenue | t × Q after the tax |
| Subsidy cost | s × Q after the subsidy |
| Price sellers keep (tax) | price buyers pay − t |
| Price sellers receive (subsidy) | price buyers pay + s |
| Buyers’ share of a tax | rise in the price buyers pay |
| Sellers’ share of a tax | fall in the price sellers keep |
| DWL of a tax or subsidy (straight lines) | ½ × t (or s) × change in quantity |
| DWL of a price control or quota | ½ × (efficient Q − traded Q) × (demand price − supply price at traded Q) |
| Policy | Q traded | CS | PS | Government |
|---|---|---|---|---|
| Binding ceiling | falls | may rise or fall | falls | — |
| Binding floor | falls | falls | may rise or fall | — |
| Tax | falls | falls | falls | gains revenue |
| Subsidy | rises | rises | rises | pays more than CS + PS gain |
Incidence rule: the more inelastic side bears more of a tax and gains more of a subsidy.
Assumptions
- A perfectly competitive market with no externalities (so the starting equilibrium is efficient).
- Under shortages, units go to the buyers who value them most (otherwise the loss is larger).
Mistakes to avoid
- Drawing a ceiling above equilibrium or a floor below it and calling it binding.
- Shifting a curve for a price ceiling or floor.
- Using quantity demanded as the amount sold under a ceiling.
- Counting tax revenue as part of the deadweight loss.
- Assuming the side that hands over the tax bears it.
- Forgetting to label both prices (buyers pay, sellers keep) on a tax graph.
Quick self-check
- Qd = 100 − 2P and Qs = 3P − 50, with a $5 tax on sellers. Find the prices and quantity. (Equilibrium was $30 and 40. With the tax: 100 − 2P = 3(P − 5) − 50, so P = $33 for buyers, $28 for sellers, Q = 34.)
- Revenue and DWL? (5 × 34 = 170; DWL = ½ × 5 × 6 = 15.)
- Who bears more of the tax, and why? (Buyers, $3 of $5: demand is less elastic than supply here.)
Next: practice questions.